The European Securities and Markets Authority is demanding greater transparency and disclosure in the way money managers use client commissions to pay for research from brokers.
In its final technical advice published Dec. 19, ESMA presented an updated version of its proposals for Markets in Financial Instruments Directive II, which took into account industry responses to a consultation paper published in May.
The majority of respondents to the May paper disagreed with ESMA’s proposal of treating investment research payment as an inducement. “Several respondents argued that the ESMA proposal could lead to a number of unintended consequences: massive increase of costs for active managers in the EU and competitive disadvantage of smaller asset managers and raising barriers to entry for new asset managers,” ESMA said in its new technical advice.
Money managers will continue to be able to pay for third-party research out of commissions, but “only where they pay for it directly or from a ring-fenced research account that is funded by a specific charge to their clients,” subject to certain conditions, said the ESMA paper. “The proposal makes clear that there should be no payment for third-party research linked to the payments made for execution of orders. This will address the potential inducements and conflict-of-interest issues that currently exist for portfolio managers when they receive third-party research linked to execution arrangements with the broker.”
ESMA’s proposal has been welcomed by the industry.
“There has been a change in (ESMA’s) position — the original position would have made it uneconomic for fund managers to continue to buy any research through dealing commissions,” said Daniel Godfrey, CEO at the Investment Management Association, a trade body representing U.K. money managers, in a telephone interview. “What they have done is, at first glance, appear to have built a very controlled regime to manage the current conflicts of interest,” rather than breaking down the existing system.
“(ESMA) is saying that fund managers may continue to pay for research but only under very controlled circumstances, or they pay for the research themselves,” Mr. Godfrey said. Controls include advance agreements, budgets that are set by senior executives, and that clients be charged separately for investment research. “That is quite a big set of changes,” he said.
The proposals are designed to manage conflicts of interest, mainly between clients, Mr. Godfrey said, “to make sure that each individual fund or client is getting value for the money they spend on research, and are not inadvertently cross-subsidizing other clients.”
